PARIS GRADUATE SCHOOL OF MANAGEMENT
BACHELOR OF BUSINESS ADMINISTRATION
FINAL EXAMINATION
SUBJECT : C 306 BUSINESS FINANCIAL MANAGEMENT
TIME: 6:30 PM – 9:30 PM
DATE:
DURATION: 3 HOURS
INSTRUCTIONS:
1. There are 7 printed pages in this paper including the cover page.
2. There are 2 sections in this paper
SECTION A – Answer all questions (40 marks)
SECTION B – Answer all questions (50 marks)
3. Clearly indicate answers, workings and calculations to all questions on this
paper
4. This is a open-book exam. Students are allowed to refer to their notes and
books.
DO NOT OPEN THIS BOOKLET UNTIL YOU
ARE INSTRUCTED TO DO SO.
DO NOT OPEN THIS BOOKLET UNTIL YOU
ARE INSTRUCTED TO DO SO.
PGSM – Bachelor of Business Administration
C 306 Business Financial Management
Page 2 of 7
SECTION A ( 2 mark each )
Answer all questions.
1. Which of the following is a basic principle when estimating a project's cash flows?
a. cash flows should be measured on a pretax basis
b. cash flows should ignore depreciation because it is a non-cash charge
c. only direct effects of a project should be included in cash flow calculations
d. cash flows should be measured on an incremental basis
Net operating cash flows
2. Which of the following items is not considered as a part of the net investment
calculation?
a. the first year’s net cash flow
b. increase in net working capital
c. salvage of an old piece of equipment that is being replaced
d. installation and shipping charges
3. . A drill press costs $30,000 and is expected to have a 10-year life. The drill press will
be depreciated on a straight-line basis over 10 years to a zero estimated salvage value.
This machine is expected to reduce the firm's cash operating costs by $4,500 per year. If
the firm is in the 40 percent marginal tax bracket, determine the annual net cash flows
generated by the drill press.
a. $4,500
b. $900
c. $5,700
d. $3,900
4. . The disadvantages of the payback approach include:
a. cash flows after the payback period are ignored in the calculation
b. payback ignores the time value of money
c. payback fails to provide an objective decision-making criterion
d. all of the above
5. The relationship between NPV and IRR is such that:
a. both approaches always provide the same ranking of alternative investment
projects.
b. the IRR of a project is equal to the firm's cost of capital if the NPV of a project is $0.
c. if the NPV of a project is negative, the IRR must be greater than the cost of capital.
d. none of the above
6. The net present value method assumes that cash flows are reinvested at the
_________, whereas the internal rate of return method assumes that cash flows are
reinvested at the _________ .
a. discount rate, required rate of return
b. cost of capital, market rate of return
c. firm's cost of capital, computed internal rate of return
d. marginal cost of capital, discount rate
7. Two prominent finance researchers (Modigliani and Miller) showed that
a. the firm's optimal capital structure consists of approximately equal proportions of debt and
equity
b. the value of the firm is independent of its capital structure in perfect capital markets with no
income taxes
C306/Jan2007
PGSM – Bachelor of Business Administration
C 306 Business Financial Management
Page 3 of 7
c. the firm's cost of capital is minimized when its capital structure consists of approximately equal
proportions of debt and equity
d. none of the above
8. . Which of the following statements (if any) is (are) true concerning the optimal capital
structure?
a. At the optimal capital structure, the weighted cost of capital is maximized.
b. At the optimal capital structure, the value of the firm is maximized.
c. a and b
d. none of the above
9. According to Miller and Modigliani it is
a. investment policy
b. dividend policy
c. a and b
d. none of the above
that really determines a firm's value.
10. Firms with the _______ earnings growth tend to have the ________ dividend
payout ratio.
a. highest, highest
b. highest, lowest
c. lowest, lowest
d. none of the above are correct
11. The dividend _______ states that investors will tend to be attracted to firms that
have dividend policies consistent with the investor’s objectives
a. "clientele effect"
b. "informational content"
c. signal
d. passive residual theory
12. What is the inventory conversion period for O’Brian's if it has sales of $320,000, an
average inventory of $5,333, and a cash conversion cycle of 20 days? Assume that the
cost of sales is 55 percent of sales.
a. 6 days
b. 11 days
c. 13.5 days
d. 15 days
13. When the level of working capital is increased, all of the following are expected to
occur except
a. expected profitability decreases
b. expected profitability increases
c. risk decreases
d. none of the above
14. All other things being equal, a policy of holding a relatively ______ proportion of
the firm's total assets in the form of current assets will tend to result in a ______
expected profitability or rate of return on the total assets of the firm.
a. large, higher
b. small, higher
c. constant, higher
d. constant, lower
C306/Jan2007
PGSM – Bachelor of Business Administration
C 306 Business Financial Management
Page 4 of 7
15. The value of an option depends on the stock’s price, the risk-free rate, and the
a. Exercise price.
b. Variability of the stock price.
c. Option’s time to maturity.
d. All of the statements above are correct.
16. American Hardware, a national hardware chain, is considering purchasing a
smaller chain, Eastern Hardware. American’s analysts project that the merger will
result in incremental net cash flows with a present value of $72.52 million, and they
have determined that the appropriate discount rate for valuing Eastern is 16 percent.
Eastern has 4 million shares outstanding. Eastern’s current price is $16.25. What is
the maximum price per share that American should offer?
a. $16.25
b. $16.97
c. $17.42
d. $18.13
17. If one Swiss franc can purchase $0.71 U. S. dollars, how many Swiss francs can
one U. S. dollar buy?
a. 0.71
b. 1.41
c. 1.00
d. 2.81
18. The effect of a one dollar increase in depreciation expenses is to ________ the
typical firm's net cash flows by _______ one dollar.
a. increase, less than
b. increase, exactly
c. decrease, more than
d. increase, more than
19. Laurier Inc. is a household products firm that is considering developing a new
detergent. In evaluating whether to go ahead with the new detergent project, which of
the following items should Laurier explicitly include in its cash flow analysis?
a. The company will produce the detergent in a vacant facility that they renovated
five years ago at a cost of $700,000.
b. The company will need to use some equipment that it could have leased to
another company. This equipment lease could have generated $200,000 per year
in after-tax income.
c. The new detergent is likely to significantly reduce the sales of the other detergent
products the company currently sells.
d. Statements b and c are correct.
20. Albany Motors recently completed a 2-for-1 stock split. Prior to the split, the
company had 20 million shares outstanding and its stock price was $45 per share.
After the split, the total market value of the company’s stock equaled $900 million.
What was the price per share of the company’s stock following the stock split?
a. $45.00
b. $30.00
c. $22.50
d. $15.00
C306/Jan2007
PGSM – Bachelor of Business Administration
C 306 Business Financial Management
Page 5 of 7
SECTION B ( 5 marks each )
Answer all questions and show all workings.
1. . Faris currently has a capital structure of 40 percent debt and 60 percent equity, but is
considering a new product that will be produced and marketed by a separate division. The new
division will have a capital structure of 70 percent debt and 30 percent equity. Faris has a current
beta of 1.1, but is not sure what the beta for the new division will be. AMX is a firm that produces
a product similar to the product under consideration by Faris. AMX has a beta of 1.6, a capital
structure of 40 percent debt and 60 percent equity and a marginal tax rate of 40 percent. If Faris’
tax rate is 40 percent, estimate the levered beta for the new product division?
2. . Calculate the market value of Lotle Group, a firm with total assets of $80 million and $30
million of perpetual debt in its capital structure. The firm's cost of equity is 14% and the cost
of debt is 9%. Lotle expects annual, perpetual net operating income (EBIT) of $9 million and
a marginal tax rate of 40%.
3. Technico has determined that its optimal capital structure is 40% debt, at which point its
weighted cost of capital, ka, is 13.7%. Due to financial problems, the firm has decided to
raise the proportion of debt to 50%, which will increase its weighted cost of capital to 14.4%.
What is the effect on the stock price of Technico? The current dividend is $1.60 and the
long-term growth rate of dividends is expected to be 8.5%.
4. Gates Industries balance sheet and income statement for the year ending December
31, 1978 are as follows:
Balance Sheet ($ million)
Cash
$10.0 Accounts payable
Accounts receivable 15.0 Salaries, benefits, & payroll taxes payable
Inventories*
12.0 Long-term debt
Fixed assets (net)
30.0
Stockholders' equity
Total assets
$67.0
Total liab. & stock. equity
Income Statement ($ million)
Net sales (all credit)
$125.0
Cost of sales
75.0
Selling, general, & adm. expenses 30.0
Other expenses
13.0
Earnings after tax
$ 7.0
*Note: Average inventories also equal $12.0 (million).
Determine the length of the firm's cash conversion cycle.
C306/Jan2007
$15.0
3.0
15.0
34.0
$67.0
PGSM – Bachelor of Business Administration
C 306 Business Financial Management
Page 6 of 7
5. St. John’s Paper is considering purchasing equipment today that has a depreciable
cost of $1 million. The equipment will be depreciated on a MACRS 5-year basis, which
implies the following depreciation schedule:
Year
1
2
3
4
5
6
MACRS
Depreciation
Rate
0.20
0.32
0.19
0.12
0.11
0.06
Assume that the company sells the equipment after three years for $400,000 and the
company’s tax rate is 40 percent. Determine the after tax net cash proceed from the
sale of the asset.
6. Suppose you believe that Du Pont’s stock price is going to decline from its current
level of $82.50 sometime during the next 5 months. For $510.25 you could buy a 5month put option giving you the right to sell 100 shares at a price of $83.00 per
share. If you bought a 100-share contract for $510.25 and Du Pont’s stock price
actually dropped to $63.00, what would be your net profit (after transactions costs but
before taxes)?
7. Suppose a U. S. firm buys $200,000 worth of television tubes from a French
manufacturer for delivery in 60 days with payment to be made in 90 days (30 days
after the goods are received). The rising U. S. deficit has caused the dollar to
depreciate against the franc recently. The current exchange rate is 5.50 FF per U. S.
dollar. The 90-day forward rate is 5.45 FF/dollar. The firm goes into the forward
market today and buys enough French francs at the 90-day forward rate to
completely cover its trade obligation. Assume the spot rate in 90 days is 5.30 French
francs per U. S. dollar. How much in U. S. dollars did the firm save by eliminating its
foreign exchange currency risk with its forward market hedge?
8. Creative Furniture is considering two mutually exclusive projects that would
automate part of their production facilities. Project A costs $120,000 and would
produce net cash flows of $37,000 annually for 5 years. Project B also costs
$120,000 and will produce annual net cash flows of $25,000 for 10 years. Creative's
cost of capital is 11 percent. Using the equivalent annual annuity method, which
project should be chosen?
9. Elliott Mfg. is considering acquiring Fox Inc. Fox’s cash flows have been
estimated in detail for the next three years and are $40M, $45M and $50M
respectively. A terminal value consistent with that estimate has been calculated at
$700M. The risk-adjusted discount rate for analysis is 12%. If Fox, Inc. has 12
million shares outstanding, what is the most Elliott should offer, per share, for its
stock?
10. As10. Assume the following facts about a company:
Capital (000’s)
Debt
Equity
Total Capital
Shares @ $10 = 300
C306/Jan2007
EBIT (000’s)
—
Less Interest Expense
$3,000 EBT
$3,000 Taxes @ 40%
Earnings after Tax
$1,000
—
$1,000
400
$ 600
PGSM – Bachelor of Business Administration
C 306 Business Financial Management
Page 7 of 7
What will be the company’s new EPS if it borrows money at 10% interest and uses it to
retire stock until capital is 40% debt? The stock can be purchased at its book value of $10
per share.
C306/Jan2007